Spain Must Go It Alone on Debt Crisis: Economist

G7 finance ministers will on Tuesday hold a conference call to discuss concerns over Spain and its financial system amid fears that if left unchecked, a run on its banking industry could spread to other euro zone nations.

Glowimages | Getty Images

Spain, which nationalized mortgage lender Bankia last month, is trying to cope with the consequences of a good old-fashioned property and lending boom which went bust and is under pressure. The nation is trying to find a solution.

A report in Der Spiegel over the weekend indicated Berlin is pushing Madrid to accept funds from the European Financial Stability Fund to recapitalize its banks.

Both Madrid and Berlin denied the report, but as the bailouts of Greece (twice), Ireland and Portugal have already indicated, a report in the German press indicating that Berlin thinks it is time for a euro zone partner to accept help is typically followed by that very thing happening.

Despite optimism that Europe is finally getting its act together on the debt crisis, there are reportedly major tensions between Spain and Germany over the terms Berlin would demand for any funds to support Spain and its banks. Madrid is believed to want help, but without having to accept giving up fiscal control to European Union and International Monetary Fund inspectors.

With Spanish 10-yearborrowing costs inching closer to 7 percent by the day, the bargaining position of Spanish Prime Minister Mariano Rajoy appears to be weakening by the day.

Not so, according to Carl Weinberg, the chief economist at High Frequency Economics, who argued in a research note Tuesday that Spain should not follow the same route as Greece and Portugal, but instead got it alone.

“The approach of the first two years of the crisis has been to lend more money to already over-indebted nations, to buy them time to reduce their budget gaps. This strategy has broadly failed, at least for Greece, and arguably for Portugal as well,” Weinberg said.

Weinberg does not expect a better outcome if Spain chooses the same path, and questions whether such an outcome would even be possible if bigger periphery euro zone members come under the gun.

“Since Spain cannot count on EMU (Economic and Monetary Union) governments to help resolve pressing problems in its banking system, we think the only possibility for avoiding a banking sector failure is for Spain to take the matter into its own hands,” he said. “Madrid can, and must, restructure its debt unilaterally.”

This could be done in Weinberg’s opinion by appointing an agent to buy up bonds due over the next 5 years on behalf of the Spanish Treasury.

“Those short-term maturities could be swapped—at acquisition cost to face value—with the Treasury for bonds over a rainbow of maturities stretching out 30 years,” said Weinberg.

When the new bonds are sold back to the market, Weinberg predicts, Spain could free up enough money to recapitalize its banking system.

“Constipated policymaking in Euroland means we cannot expect a timely resolution,” he warned. “Spain has to resolve its own problems in an orderly way. Otherwise, its banks will fail and the nation’s finances will be turned into a shambles.”